Factor productivity refers to the efficiency with which inputs (like labor and capital) are used to produce outputs (goods and services). A change in factor productivity can significantly impact long-term economic growth, which can be understood within the framework of the AS-AD model.
When factor productivity improves, it means that the same amount of input can yield a greater output. This leads to an increase in the long-run Aggregate Supply (LRAS). When you shift the LRAS curve to the right on the graph, it indicates that at every price level, the economy can now produce more goods and services. This increase in capacity enables businesses to grow, potentially leading to job creation and higher incomes.
As productivity rises, the economy can sustain a higher level of output without causing price levels to increase significantly, promoting stable economic growth over the long term. In contrast, if factor productivity declines, the LRAS shifts to the left, indicating a decrease in potential output, which can lead to lower economic growth and higher unemployment in the long run. Therefore, enhancing factor productivity is crucial for fostering sustainable economic growth.